Tom Lydon on "ETF Edge": Defensive Positioning for the Rest of 2019

Even as U.S. equities continue to see a resurgence in the first quarter of 2019, investors can still see a wall of worry growing in the backdrop, which is sparking concerns of a global economic slowdown. Even if a permanent trade deal between the U.S. and China gives equities a healthy boost in the short-term, it won’t allay long-term concerns–this is where defensive positioning comes into play.

Whether it’s delving into safe havens like commodities or more specifically, precious metals like gold, investors are looking to play defense despite the run up in equities as of late. Additionally, investors are looking to play more defense against volatility, but at the same time, don’t want to do so at the expense of higher costs.

A Creative Spin on Low Volatility and Low Cost

Low volatility and low cost is where the Salt Low truBeta™ US Market ETF (CBOE: LSLT) comes into play, but with its own spin–LSLT is essentially seeking to become a negative fee ETF (pending SEC approval) where investors earn $5 for every $10,000 invested or five basis points. The rebate will be capped if the fund reaches $100 million in assets, but as of now, LSLT is listed at 29 basis points.

It’s a creative play for an ETF that is at disadvantage when it comes to garnering assets compared to multinational investment banks like JP Morgan who has the ability to tap into its own client capital.

“The executives at Salt are brilliant,” said ETF Trends CEO Tom Lydon during an episode of CNBC’s “ETF Edge” with Bob Pisani. “Is it a marketing ploy? Maybe, but it’s probably a great one because the money is going into low cost ETFs and if all of a sudden, if they hit that $100 million mark very quickly because they’re financing this, good for them because now they’re going to be available on platforms that you normally can’t get on Morgan Stanley or Merrill Lynch, unless you have $100 million.”

“Getting through the gatekeeper is key and assets are a big thing,” added Lydon.

Even at 29 basis points, LSLT comes at a discount for its smart beta strategy–a must for investors with a 2019 that could foresee volatile challenges ahead as market movers like trade wars and interest rates contribute to this wall of worry for investors.

Equities Have Glitter, but Don’t Forget Gold

The end of 2018 burned an image of volatility in investors’ minds that would drive their decisions when reassessing their portfolios for 2019. As such, alternatives to diversify and counteract volatility would be on the investment agenda, making ETFs like the commodities and precious metals a prime alternative.

During the bout of volatility that took hold of the capital markets near of the end of 2018, stocks and bonds did something they don’t normally do–show signs of positive correlation. As equities were getting roiled with volatility, the tried and true safe haven of Treasuries were falling as yields were climbing.

This lockstep between stocks and bonds was not something typically seen within the capital markets as both are prone to marching to the beat of their own drum.

Commodities, however, lack correlation to both stocks and bonds–something investors will appreciate moving forward as a volatility protection measure. Commodities-focused ETFs like gold could continue gaining assets, such as the GraniteShares Gold Trust (NYSEArca: BAR).

Once again, with costs in mind, it’s an idea gold play option for investors focused on low costs. BAR represents one of the cheapest commodity ETFs on the block with a 0.17% expense ratio.

“For a lot of people, fees will be the most important thing,” said Will Rhind, CEO of GraniteShares.

“We came in with the lowest cost gold ETF with BAR and a lot of people will focus on that as they rightfully should because low fees are important,” added Rhind.

In 2018, rising interest rates that coincided with an extended bull run in U.S. equities for most of the year fueled a strong dollar, tamping down gains for gold. However, when investors got washed in a cycle of volatility that started in the fall and lasted through year’s end, investors were quick to reconsider the precious metal as a safe haven, which helped ETFs backed by gold.

“You saw it at the end of last year when the stock market sold off pretty dramatically while gold prices went on a pretty significant rally,” said Rhind.

“Look at this price and think of defensive positioning,” added Rhind, referring to gold at its current level as a buying opportunity as fears of a global slowdown permeate the capital markets.

With the latest Fedspeak sounding more dovish as it now projects two interest rate hikes in 2019 as opposed to three or more, this could be the trigger for gold to return to come back into the forefront, particularly as a safe-haven option in the wake of more volatility. While bonds are typically the default play when U.S. equities go awry, gold is a prime option for diversification as a safe alternative.

Despite the headwinds of rising rates and a stronger dollar in 2018, some analysts feel that gold has weathered the storm and presents a prime buying opportunity in 2019. For the last 10 years, gold has proven to be a consistent performer, yielding 5.1 percent.

“During recessionary times, gold tends to do better,” said Lydon. “If you look back during the financial crisis, the early 2000s, those were a great time to own gold.”

Focus on Low Costs Hurting Active Managers

The latest Morningstar Active/Passive Barometer report revealed that only 38 percent of active U.S. equity funds survived and outperformed their average passive counterparts in 2018, which represents a 9 percent drop from 2017. With the increasingly dismal performance by active funds, it argues the case for more investors to use ETFs, particularly the passive variety.

The number of passive ETFs are over 1,100 compared to active, which comprises over 250. This availability of passive options makes the case for investors to seek ETFs compared to their mutual fund brethren, which are typically actively-managed and carry higher operation costs.

Once more, with investors focusing on costs, the latest performance figures by active management simply doesn’t justify their expenses. To the budget-minded investor, these active funds are simply blowing smoke.

“I think active management is going the way of cigarettes–back in the 70s and 80s, mutual funds were hot, they were rock stars, but fast forward to today, active management is not healthy, it’s not as cool, and it’s expensive,” said Lydon.

For more market trends, visit ETF Trends.